EMU inflation and Lautenschlaeger in focus today

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Dudley's comments echo through markets; strong data

Global core bonds lost more ground yesterday with markets adapting further to NY Fed governors Dudley's comments just before the closing bell on WS Tuesday. The influential Fed governor paved the way for a March 15 rate hike. We expect vice-chair Fischer and chairwoman Yellen to seal the deal in public speeches on Friday. The market implied probability of a 25 bps rate hike increased from less than 40% at the end of last week to 84% currently. Higher than expected German inflation (2.2% Y/Y), strong bourses (sign that higher rates are appropriate), a stronger dollar and a catch-up move with Tuesday evening brought Bund losses in line with US Treasury losses. The US PCE deflator increased from 1.6% y/y to 1.9% y/y in January, just below 2% y/y consensus, but nearly hitting the Fed's inflation target. The US manufacturing ISM sky-rocketed to 57.7 (56), the highest since August 2014 with bright sub-indices, confirming the acceleration of growth and keeping US Treasuries at daily lows.

In a daily perspective, the US yield curve shifted 2.4 bps (2-yr) to 6.5 bps (10-yr) higher. From a technical point of view, the US 2-yr yield reached a minor new cycle high north of 1.3%, but couldn't sustain above and closed at 1.29%. The US 10-yr yield (now 2.45%) moves in a tearing rush from 2.3% support to 2.52/2.55% resistance. Contrary to yesterday, the US curve now bear steepened. The German yield curve slightly bear steepened with yields 7.2 bps (2-yr) to 8.7 bps (30-yr) higher. The shorter end reacts on a further easing of political tensions and the unwinding of the long overdone rally. On intra-EMU bond markets, 10-yr yield spread changes versus Germany narrowed up to 5 bps for Spain, Belgium and France. French Republican president candidate Fillon vowed to stay in the race even now he's charged with misuse of public funds, which only raises the chances of the current centrist presidential candidate, Macron, the markets' favourite.

EMU inflation and Lautenschlaeger in focus today

The main economic release is the EMU HICP inflation for February. The market expects a 0.2%-point increase to 2% Y/Y for the headline figure and a 0.9% stabilization of the core. Given the recent increase in consensus estimate and taken into account other national inflation data, we side with expectations meaning that the 2% ECB target will be reached, a psychologically important event. Of course, core inflation will stick close to 0.9% Y/Y. The headline inflation number, together with strong eco data, nevertheless increases chances that the ECB will prematurely dial back its asset purchases during H2 of 2017. Regarding central bankers, ECB Lautensclaeger, a hawk, speaks after closure. She recently said "I am thus optimistic that we can soon turn to the question of an exit from quantitative easing" She is a loner inside the dovish Executive Committee.

France and Spain tap market

The French Treasury taps the on the run 10-yr OAT (0.25% Nov2026), 20-yr OAT (1.25% May2036) and 50-yr OAT (1.75% May2066) for a combined €6-7B. ASW spreads of the bonds on offer narrowed in the run-up to the auctions and the bonds are slightly expensive on the French curve. They still trade with an "election discount" though. Nevertheless, we expect a decent auction given that calm returned to the French bond market as Macron became the clear frontrunner in the French presidential election race. The Spanish debt agency taps the on the run 5-yr Bono (0.4% Apr2022) and 10-yr Obligacion (1.5% Apr2027) for €3-4B. The bonds on offer traded stable in the run-up to the auction, but are also slightly expensive on the Spanish curve. We expect plain vanilla demand. Additionally, the Spanish debt agency raises €0.5-1B via inflation-linked bonds.

No rebound for core bonds ahead of Yellen

Overnight, most Asian stock markets trade positive but sentiment is less ebullient than in Europe and the US yesterday. China underperforms (-0.5%). The US Note future remains near yesterday's lows as dovish and influential Washington-based Fed governor Brainard joined the chorus that a rate hike is imminent. We expect a neutral opening for the Bund.

Today's eco calendar only contains EMU CPI, which is expected to hit the ECB's 2% inflation target and will generate a lot of media attention and might be negative for the Bund today. In light of this week's hawkish Fed comments and the surge of the market implied probability of a March Fed rate hike (from 50% to 84%), we don't expect US Treasuries to rebound ahead of speeches by Fed Fischer and Yellen (tomorrow) who will probably seal the deal ahead of the Fed's blackout period. Technically, the US 2-yr yield tests the cycle high (1.3%), while the 10-yr yield bounced off key support (2.3%), suggesting more upside.

The German 10-yr yield tested similar support around 0.17%/0.2%. Recent developments in Greece and France improved sentiment on EMU bond markets. Longer term, we hold our bearish view also for Bunds as we expect a new "calibration" of the ECB's QE programme in H2 2017.

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